StarHub Limited - Anticipating Growth In Enterprise

Anticipating growth in enterprise from resumption of smart nation initiatives.

Pay-TV business could improve with better cost management initiatives.

TPG Telecom is unlikely to pose a serious threat to the incumbents.

StarHub's $210mn restructuring exercise will help cushion the decline in mobile and pay-TV.

We initiate with an ACCUMULATE rating with a target price of S$1.88.

Company Background

STARHUB LTD (SGX:CC3) was listed on the Singapore Exchange mainboard since 2004 and is the 2nd largest telecommunications provider by market capitalisation in Singapore.

StarHub offers communications, entertainment and digital solutions through its extensive fibre and wireless infrastructure. StarHub develop and deliver to corporate and government client solutions such as artificial intelligence, cyber security, data analytics, internet of things and robotics. OpenSignal’s state of Mobile network awarded StarHub for the fastest 3G & 4G network in Singapore.

Investment Merits

Pay-Tv business could improve. The Pay-tv business is operating in a challenging environment. StarHub’s management is in the midst of renegotiating with content providers to switch from a fixed cost model to a variable cost model. If successful this could help the pay-tv business to improve with a better cost structure to alleviate margin pressures.

Anticipating growth in enterprise fixed. Enterprise fixed has been growing at an average rate of 7.2% p.a. since FY16. We expect this growth to continue as StarHub focuses its efforts on enterprise to help offset the weakness in mobile and pay-tv. The resumption of smart nation projects should give StarHub more opportunities. StarHub bets big on its enterprise business with the consolidation Accel Systems and D’Crypt and a new joint venture with Certis Cisco to form a pure-play cybersecurity company.

$210mn restructuring exercise will help cushion the decline in mobile and pay-tv. The cost savings is projected to be over 2019 to 2021 and will be driven by staff reduction and cost reductions in procurement, leasing, repairs and maintenance and distribution. A portion of savings will be channelled to investment opportunities. We expect the exercise to offset the declines in mobile and pay-tv, this should help stabilise earnings.

TPG Telecom is unlikely to pose a serious threat. TPG announced CAPEX of S$200-300mn for the mobile network rollout and have thus far spent less than S$100mn. The low level of CAPEX should prevent consumers from being eagerly switching to the new player in town due to network reliability, coverage and quality issues. In addition, the price-sensitive segments where TPG is likely to compete in is filled with MVNOs with far superior network than TPG. TPG is giving free trials for the first 20,000 customers that register their interest with them. The 20,000 only represent 0.38% of total post-paid customers and even less significant on revenue as this customers are in the price-sensitive space. This has led us to believe TPG’s entrance is unlikely to pose a serious threat to the incumbents.

Mobile Segment

Latest post-paid subscriber numbers grew 1.7% y-o-y or 23k. We believe the addition was boosted by StarHub’s MVNO partner MyRepublic after its commercial launch in May 2018. The mobile segment is facing several structural changes. Smartphone replacement cycles are getting longer, resulting in the rise in popularity of SIM-Only plans. These SIM-Only plans are low ARPU products. To make matters worse, the price sensitive market is filled with MVNOs competing for market share; this puts further pressure on ARPU. We expect mobile ARPU to continue its weakness in the medium term as the market braces for the entry of TPG. The market should rationalise upon digesting the strategies of TPG telecom. (See sector report for a detailed explanation on SIM-only plans & MVNOs)

That being said, we think TPG will not pose a serious threat to the incumbents. TPG announced CAPEX of S$200-300m for the mobile network rollout and have thus far spent less than S$100m. The low level of CAPEX should prevent consumers from being too eager to switch to the new player in town due to network reliability, coverage and quality issues. In addition, the price sensitive market where TPG is likely to compete in is filled with MVNOs with far superior network than TPG. Key risk to this view is if TPG significantly ramp up spending on their 4G network in 1H19. Nevertheless we have factored in a 5% decline in post-paid subscribers across the 3 telcos. The decline is ~2% of total revenue, which is partially offset by growth in enterprise.

Broadband Segment

The broadband business is expected to face sustained competition due to the high broadband penetration in the market. StarHub differentiate itself by offering advanced Wi-Fi and mesh routers that enhances user experience. We expect broadband ARPU to be range bound as we do not foresee large movements in prices.

StarHub announced in November 2018 that it plans to cease providing broadband and Pay-tv services using the Hybrid Fibre Coaxial (HFC) network by June 2019. This date is earlier than the proposed disconnection in 2020. This means all existing broadband and pay-tv subscribers will be transferred to the National Broadband Network (NBN) as a result StarHub will decommission its HFC network after June 2019. In light of this, we expect to see a spike in cost of services in FY19. StarHub is to incur approximately S$14mn in fibre leasing cost per annum.

Pay-TV Segment

The pay-TV business model is broken. The segment is being heavily disrupted by Over-The-Top (OTT) players such as Netflix, Amazon video and Hulu Plus. OTT players have been changing the way people consume content with videos on demand, original content and cheaper monthly subscriptions. These cheaper alternative players have cost StarHub 100K subscribers since 2016. We have factored in a decline of ~6% in subscribers for FY19e in our model.

The pay-TV business model is under pressure from declining ARPU and declining subscribers, whilst content-cost is fixed. We believe StarHub recognises that the business model is broken and is renegotiating with content providers to switch from a fixed-cost model to a variable cost model. If successful, the pay-tv business could improve as this manages the costs to help alleviate margin pressures.

The enterprise segment is benefitting from the resumption of smart nation projects and demand from businesses especially from small & medium enterprise (SME), hospitality and financial services. Companies are requiring more connectivity, data centre and cloud, managed security and network services. We believe Singtel and StarHub is well positioned to take advantage of this growth.

StarHub is undertaking a massive investment in the enterprise segment. Starhub expanded its enterprise segment by an average rate of 7.2% p.a. since FY16 and 13% y-o-y in the 3Q18. This is driven mainly by its managed services segment offsetting declines in the traditional data & internet and voice services. The performance in managed services is largely driven by the consolidation of acquisitions Accel Systems and D’Crypt. In addition, to tap on the growing demand for cyber security StarHub and a Temasek wholly-owned subsidiary has formed a joint-venture company named Ensign InfoSecurity Pte Ltd. Ensign is a pure-play cyber security company. It aspires to be a global cyber security platform to address the demand in both Singapore and global market. Expected revenue is in the excess of S$100mn annually. StarHub has a 40% ($36mn) stake in Ensign.

We expect enterprise to be a key growth driver. We think StarHub is well positioned for the opportunity in the cyber-security and managed services space and we are optimistic that there is market demand to support this growth given the resumption of government smart initiatives and the growing demand in SME, hospitality and financial services.

Valuation

We initiate coverage on StarHub with an ACCUMULATE rating and a target price of S$1.88. Our target price is based on FY19e 6X EV/EBITDA.

We gave a 35% discount to StarHub’s regional peers as we take a conservative view of the mobile and pay-tv business.

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